Ho, Ho, Uh-Oh: The SEC continues to focus on non-GAAP disclosures

Lest you think that the SEC’s focus on the use of non-GAAP financial metrics is so, well, 2018, think again. On December 26, the SEC issued a cease-and-desist order against a company based entirely on the company’s use of non-GAAP metrics without giving “equal or greater prominence [to] the most directly comparable financial measure or measures calculated and presented in accordance with GAAP…”, as required by Item 10(e)(1)(i)(A) of Regulation S-K.

According to the SEC order, the company in question – ADT, the security company based in Boca Raton, Florida – issued earnings releases for fiscal 2017 and the first quarter of fiscal 2018 that prominently included such non-GAAP metrics as adjusted EBITDA, adjusted net income, and free cash flow before special items, without giving equal or greater prominence to the comparable GAAP data. For example, the order states:

“In the headline of the FY 2017 earnings release, ADT presented its adjusted EBITDA for fiscal year 2017 and stated that adjusted EBITDA was up 8% year-over-year, without mentioning ADT’s net income or loss (the comparable GAAP financial measure) in the headline”

And in the release covering results for the first quarter of fiscal 2018,

“On the top of the first page, ADT then listed “FIRST QUARTER 2018 HIGHLIGHTS” in nine bullet points, including bullet points that state ADT’s adjusted EBITDA of $620 million was up 7%, adjusted net income of $249 million was up 26%, and adjusted net income per share of $0.34 was up 10%. These three measures are all non-GAAP financial measures. ADT did not include comparable GAAP financial measures for net income or loss in the HIGHLIGHTS section. Instead, ADT reported in the second and sixth full paragraphs that its GAAP net loss had increased from $141 million for Q1 2017 to $157 million for Q1 2018.”

Maybe it’s just me, but these examples seem pretty obvious to me. In other words, if you’re going to include non-GAAP metrics in a headline, that headline needs not only to include the comparable GAAP metric, but also to list the GAAP metric first (or to otherwise give it prominence). Similarly, it seems only logical that if you’re going to use bullet points – as is often the case – to set out the period’s highlights – you shouldn’t limit the data in those bullet points to non-GAAP data.

However, I’ve had conversations with otherwise eminently sensible people who don’t seem to understand what “equal or greater prominence” means. If you fall into that group, here are some suggestions:

List the GAAP data first, even if the non-GAAP data make the numbers look better. This seems obvious.

Don’t show non-GAAP data in bold face or italics, or in a larger font, while showing GAAP data in regular font.

Don’t have three paragraphs about the non-GAAP data followed by a sentence covering the GAAP data.

When you provide the required reconciliation between the GAAP and non-GAAP numbers, consider explaining why the non-GAAP numbers look better; after all, if they didn’t, you probably wouldn’t be using them.

When you explain why you’re using non-GAAP data, don’t give a lame reason like “investors may find this useful”. There’s a good chance your investors find lots of things useful that you don’t provide, so this seems to me to be a weak reed indeed. It’s fine to say, “many investors who follow our company and our peers have asked us to provide this number” or “this is the way we look at the company” and so on. And if you still don’t believe me, think how you feel when the SEC proposes a particularly silly disclosure requirement on the grounds that “investors may find the information useful.”

In any case, the SEC clearly continues to be interested in this topic, so proceed accordingly.

Bob Lamm chairs Gunster’s Securities and Corporate Governance Practice Group.He has held senior legal positions at several major companies – most recently Pfizer, where he was assistant general counsel and assistant secretary; has served as Chair of the Securities Law Committee and in other leadership positions with the Society for Corporate Governance; and is a Senior Fellow of The Conference Board Center for Corporate Governance.Bob writes and speaks extensively on securities law and governance matters and has received several honors, including a Lifetime Achievement Award in Corporate Governance from Corporate Secretary magazine.